Investment Insights: October Review November 15, 2017

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1 Investment Insights: October Review November 15, 2017 Asset Allocation & Market Strategy A Cool Hundred The U.S. economy hit an incredible record in October; it has now been in an expansion for its 100 th month, which is a number that has only been exceeded two other times in history. Consequently, the equity market domestically has also seen historic gains with positive numbers in the most recent month bringing the year-to-date total return for the S&P 500 Index to percent. Many investors thought a continuation of the upward trend in equities was possible in 2017, but the pace may be surprising to some. The steepness of the climb in global equity returns has actually even increased toward the end of this year with the MSCI All Country World Index excluding the United States gaining percent so far this year. Much of the increase can be attributable to a generous economic landscape for corporations and consumers. For example, unemployment rates have dropped across the globe and U.S. data reports show unemployment at 4.1 percent in October, its lowest since The European Union s unemployment level is 8.9 percent and has dropped below its 20-year average in September. A combination of better employment, low inflation, and historically low interest rates has translated into a stronger consumer better balance sheets, lower liabilities, and more income. The University of Michigan Consumer Sentiment Index hit a level of over 100 in October, which was last seen in December of This confidence has also trickled into corporate earnings and into the Federal Reserve s decisions to continue raising rates and unwind its balance sheet. Financial markets have seemed to reach a vote of confidence for the likely new Fed Chair. Volatility in the Treasury market has seemed to dissipate and rates have remained stable as Jerome Powell prepares to take the helm of the Federal Reserve. The ability to analyze Powell s voting history and his background has installed confidence in his future ability to lead the central bank. The majority of our alternative investments have created positive contributions to performance and have aided in risk reduction, since these assets move independently of stocks and bonds. We have continued to look toward alternatives when capturing profits in equities in an attempt to stabilize the risk-return profiles of our strategies. For now, the Global Investment Management team remains optimistic over the interim and holds a tilt toward risk assets like equities, and credit over government within fixed income allocations. We don t expect a market shock such as a recession in the foreseeable future; most of the risk is currently coming from Washington, either in the form of surprises in fiscal policy or changes in monetary policy from the Fed. Equities New Trades for a New Year Stocks continued their seemingly unending rise in October with the S&P 500 Index reaching 2,575 to end the month. Global stock markets posted positive returns and domestic equities outperformed despite political issues in the U.S. The S&P 500 Index returned 2.33 percent for the month, which led developed markets. The MSCI ACWI Index, which attempts to gauge global stock markets, gained 2.10 percent, and the MSCI EAFE posted a 1.53 percent advance showing potential for developed international markets. Emerging market stocks continue to be a top performer for 2017 and climbed 3.51 percent in October, which brought the year-to-date gain to percent, according to MSCI data. Page 1 of 5

2 Politics was a key factor for domestic markets again in October, as the special investigation into Russia s potential tampering with the 2016 U.S. presidential election heated up with a few arrests. To add to the intrigue, ominous comments from President Trump during a meeting with senior military staff left investors uncertain on the tensions between the U.S. and North Korea. Later in the month, the Senate approved a budget measure which also gave them the power to push through a Republican tax plan an issue that has topped headlines in recent weeks. Despite the ups and downs, equity markets have remained resilient and continue their trend upward alongside economic growth globally. The Global Investment Management team recently made adjustments to our strategies to improve positioning going forward. Our team removed our overweight to Chinese stocks after strong returns so far in 2017 almost 50 percent according to MSCI data and as the Chinese government attempts to curb its expansion in credit to stabilize growth. We also removed our hedged European equity exposure, which showed strong appreciation from the underlying European stocks and also as the U.S. dollar declined throughout The proceeds of these sales were reinvested back into broad international developed, broad emerging markets, and U.S. large cap stocks. We believe these changes have improved our positioning in the markets and captured gains for our clients. We continue to look toward European stocks as an opportunity going forward, but have become a little wary of emerging markets. Fixed Income The Fed s Succession Plan A heating economy and potential changes to fiscal and monetary policy caused bond markets to ebb and flow during the month of October. As Republican lawmakers closed in on a proposal for tax reform, the 10-year Treasury yield began to climb and ended the month at 2.38 percent. Despite the rise, the overall bond market was able to eke out a positive return with the Barclays U.S. Universal Index gaining 0.12 percent. A stronger economy and earnings helped corporate debt returns with investment grade bonds gaining 0.40 percent and high yield bonds gaining 0.42 percent, according to Barclays data. The move in rates, lower relative yields, and potential interference from the Fed s unwinding plan pushed mortgage-backed securities and Treasuries into the red for October. Domestically, Puerto Rico continued to be a key issue politically and financially as the Trump administration deliberated over a possible bailout for Puerto Rican debt while the territory recovers from severe hurricane damage. Congress has approached the finalization for a tax plan that could cut taxes for individuals and corporations, which could boost growth if it incentivizes enough spending, particularly from the consumer. Rates for consumers also may be on the rise as Yellen carries out the remainder of her term and prepares for Jerome Powell, the current nominee for Fed Chair. He will likely be confirmed by the Senate based on his extended tenure in the industry. Finally, yields in the bond market may be reacting to the Fed s quantitative tightening plan, but the extent of those effects remains unknown. Our team continues to view monetary policy as a flowing plan; however, the succession plan with Powell included seems to signal the Fed will continue on its current path. Implied fed futures probability showed an over 90 percent chance for the Fed to raise rates as their December meeting based on Bloomberg data. Unsurprisingly, fiscal and monetary policy changes may end up being the largest factors for rates going forward, especially as central banks abroad begin to join the tightening movement. We recently updated our strategies to reduce exposure to mortgages with proceeds reinvested in corporate bonds and foreign bonds. Page 2 of 5

3 Alternatives Bacon, Batteries, and Battlestar Galactica Alternative assets advanced along with other major asset classes in October with commodities leading the way. The Bloomberg Commodity Index gained 2.05 percent for the month as oil reached highs not seen since the beginning of the year and the commodity seems ready to continue its climb. Global real estate saw a rise and fall from grace during October, reaching returns over 2 percent before ending the month up just 0.81 percent, according to MSCI data. Hedge fund managers continue to post positive returns, but also have to come to grips with an industry shake-up due to high fees and lower relative returns compared to previous years. Despite these pressures, the HFRX Global Hedge Fund Index returned 0.69 percent with a majority of positive performance coming from macro strategies, which invest based on the overall direction of the economy and the markets. Oil topped commodities headlines during the month as political pressures drove prices higher. A corruption crackdown in Saudi Arabia and increased demand projections from OPEC were key contributors to the move; however, North American production, specifically in shale, will likely continue to cap prices. West Texas Intermediate, the typical pricing standard for U.S. crude oil, ended October at $54.38 per barrel rising to a high of $57.35 in early November. Despite strong upward moves in crude, the real heroes in the commodity markets were nickel and lean hogs, which gained percent and percent, respectively, in October according to Bloomberg data. Nickel s sharp rise was short as prices fell going into November when predictions cooled over the metal s use in batteries and the increasing demand for electric vehicles. Lean hogs saw some decent gains after falling from a peak in the middle of the year as hog numbers grew. We believe our alternatives exposure has continued to provide a strong diversifying benefit to our strategies, but has also been largely additive to returns. Our exposure in the asset class remains geared toward income-producing, low-volatility strategies like absolute return vehicles and insurance-linked products. In the commodities space, we expect more of the same from oil until there is a substantial shift in supply and demand balances or a geopolitical event that could affect pricing. Page 3 of 5

4 Glossary Alternative investments are investments that are not one of the three traditional asset types (stocks, bonds and cash). Barclays U.S. Universal Bond Index is an unmanaged index comprising US dollar-denominated, taxable bonds that are rated investment grade or below investment grade. Bloomberg is a major global provider of 24-hour financial news and information including real-time and historic price data, financials data, trading news and analyst coverage, as well as general news. Bloomberg Commodity Index is a broadly diversified index that allows investors to track commodity futures through a single, simple measure. The Index is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME). Brexit is an abbreviation of British exit, which refers to the June 23, 2016 referendum by British voters to exit the European Union. The referendum roiled global markets, including currencies, causing the British pound to fall to its lowest level in decades. Bureau of Labor Statistics is the arm of the U.S. Department of Labor that researches and publishes a range of data, from inflation and consumer spending to employment, productivity and wages, as well as other economic measures. CBOE Volatility Index (VIX) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes. 1st & 2nd month expirations are used until 8 days from expiration, then the 2nd and 3rd are used. Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. Sometimes referred to as headline inflation. Corporate bonds are debt obligations issued by corporations. An investment in corporate bonds is subject to a variety of risks including credit and default risk, market risk, event risk, call risk, interest rate risk, foreign risk, and sector risk. Emerging Market countries have economies that are progressing towards becoming advanced, as shown by some liquidity in local debt and equity markets and the existence of some form of market exchange and regulatory body. European Central Bank (ECB) is the central bank responsible for the monetary system of the European Union (EU) and the euro currency. European Union (EU) is a group of European countries that participates in the world economy as one economic unit and operates under one official currency, the euro. The EU s goal is to create a barrier-free trade zone and to enhance economic wealth by creating more efficiency within its marketplace. Federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances. Federal Open Market Committee (FOMC) is a committee that sets interest rate and credit policies for the Federal Reserve System, the U.S. central bank. The committee decides whether to increase or decrease interest rates through open-market operations of buying or selling government securities. Federal Reserve (Fed) is the federal banking authority in the U.S. that performs the functions of a central bank and is used to implement the country s monetary policy, providing a national system of reserve cash available to banks. Frontier Markets are less advanced capital markets from the developing world. Frontier markets are countries with investable stock markets that are less established than those in the emerging markets. They are also known as pre-emerging markets. Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country s borders in a specific time period, though GDP is usually calculated on an annual basis. Real Gross Domestic Product is an inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices. Often referred to as constant-price, inflation-corrected GDP or constant dollar GDP. Real GDP can account for changes in the price level, and provide a more accurate figure. HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies; including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The strategies are asset weighted based on the distribution of assets in the hedge fund industry. High yield bonds are high paying bonds with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds. Based on the two main credit rating agencies, high-yield bonds carry a rating below BBB from S&P, and below Baa from Moody s. Bonds with ratings at or above these levels are considered investment grade. Credit ratings can be as low as D (currently in default), and most bonds with C ratings or lower carry a high risk of default; to compensate for this risk, yields will typically be very high. Investment-grade (IG) is typically used in reference to fixed income securities that possess relatively high credit quality and have credit ratings in the upper ranges of those provided by credit rating services. Using Standard & Poor s ratings as the benchmark, investment-grade securities are those rated from AAA at the highest end to BBB- at the lowest. To earn these ratings, securities, in the judgement of the rating agency, are projected to have relatively low default risk. MSCI All Country World Index (ACWI) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International, and is comprised of stocks from both developed and emerging markets. MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. and Canada. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. Municipal bonds are debt obligations issued by states, cities, counties, and other public entities that use the loans to fund public projects. The interest income from municipal bonds is generally exempt from federal taxes and may be exempt from state and local taxes. Municipal bonds are subject to a number of risks such as interest rate risk, call risk, inflation risk, credit and default risk, and tax risks. Price-Earnings Ratio (P/E Ratio) is a valuation ratio of a company s current share price compared to its per-share earnings. Russell 2500 Index features 2,500 stocks that cover the small and mid cap market capitalizations. The Russell 2500 is a market cap weighted index that includes the smallest 2,500 companies covered in the Russell 3000 universe of United States-based listed equities. The index is designed to be broad and unbiased in its inclusion criteria, and is recompiled annually to account for the inevitable changes that occur as stocks rise and fall in value. The S&P 500 Index is a capitalization-weighted index of 500 stocks traded on the NYSE, AMEX and OTC exchanges, and is comprised of industrial, financial, transportation and utility companies. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Treasuries are subject to interest rate risk, call risk, and inflation risk. As Treasuries are backed by the full faith and credit of the federal government, they have low credit or default risk. As a result they generally offer lower yields relative to other bonds. University of Michigan Consumer Sentiment Index is a consumer confidence index published monthly that collects data on consumer attitudes and expectations. The index is comprised of measures of attitudes toward personal finances, general business conditions, and market conditions or prices. One cannot invest directly in an index. Page 4 of 5

5 Disclosures The discussions and information set forth in this newsletter are for informational purposes only. They do not take into account the exceptions and other considerations that may be relevant to particular situations. These discussions and information should not be construed or used as legal or tax advice, which has to be addressed to particular facts and circumstances involved in any given situation. To comply with the Internal Revenue Service and other applicable tax practice standards, any tax information and advice contained in this newsletter is not intended or written to be used, and may not be used, for purposes of avoiding tax penalties imposed under the United States Internal Revenue Code or for the purpose of promoting, marketing or recommending to another party any tax-related matters. The discussions and information contained in this newsletter should not be construed or used as a specific recommendation for the investment of assets of any customer of Bank of the West or its affiliates and is not intended as an offer, or a solicitation of an offer, to purchase or sell any security or financial instrument, nor does the information constitute advice or an expression of the Bank s view as to whether a particular security or financial instrument is appropriate for you and meets your financial objectives. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance. This information is given without regard to the specific investment objectives, financial situations, or particular needs of any person who may receive this newsletter. Investors should seek financial advice regarding the appropriateness of any securities or strategies recommended in this newsletter. Bank of the West does not guaranty the results obtained from use of any information contained in this newsletter and will not be liable for any investment decision based in whole or in part on the information contained in this newsletter. The opinions expressed in this newsletter are those of Bank of the West s Global Investment Management Team, and neither Bank of the West or its affiliated entities shall be held liable for any content, regardless of cause, or the lack of timeliness of, any information contained in this newsletter. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO THE ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION IN THIS NEWSLETTER OR FROM ANY LINKED WEB-SITE. Investing involves risk, including the possible loss of principal and fluctuation in value. Among other risks, fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens. Alternative investments contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Diversification and asset allocation does not ensure a profit or guarantee against loss. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Important Information Regarding Bank of the West and its Affiliates Bank of the West Wealth Management offers products and services through Bank of the West and its various affiliates and subsidiaries. The discussions and information set forth in this newsletter are prepared by and are the views of the Global Investment Management Division of the Bank of the West Wealth Management Group. Securities and variable annuities are offered through BancWest Investment Services, a registered broker/dealer, Member FINRA/SIPC, and SEC Registered Investment Adviser. These products are offered by Financial Advisors who are registered representatives of BancWest Investment Services. BancWest Investment Services is a wholly owned subsidiary of Bank of the West. Bank of the West is a wholly owned subsidiary of BNP Paribas. Bank of the West and its various affiliates and subsidiaries are not tax or legal advisors. Please consult your tax or legal advisor for more information regarding your personal situation. Investment and Insurance Products: NOT FDIC INSURED NOT BANK GUARANTEED MAY LOSE VALUE NOT A DEPOSIT NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY Page 5 of 5